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Update: there is a further post on this subject here. If Warren Buffett isn't really paying the corporate income tax then we should perhaps abolish the corporate income tax.

Warren Buffett's got a piece in the New York Times today. A piece in which he makes a very strange claim about the rate of tax that he pays.

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

What he says, with the qualifications he uses, is true as far as it goes. It is, however, extremely misleading, because he's left out the effect of the corporate income tax.

There are essentially two conceptual ways in which you can tax dividends. You can tax them as income to the people who collect them: this was the system in the UK, my home country and is effectively the system now. Or you can tax the profits at the corporate level and then dividends are tax free to the recipients. Several continental European countries use this system.

The United States is different: it has elements of both systems. First, corporate profits are subject to the corporate profits tax, some 35% currently as the headline rate. Then dividends are taxed again in the hands of the recipients at the rate of 15%. This means that the effective tax rate on Buffett's dividends from Berkshire Hathaway was not the 15% that he's using in his calculation above (the 2.4% to take the total to 17.4% is presumably referring to the capped social security taxes and the income tax on his salary, not dividends).

Assume there's $100 of profit which is to be paid in dividends under each of the systems.

In the UK dividends are paid out of post tax profit, as in the US. However, that tax that had been paid on the corporate profits becomes, to the dividend recipient, a tax credit. If you are a lower rate taxpayer no further tax is due on the dividends received. Only if you are a higher rate taxpayer do you pay tax on the dividends taking your tax rate up to the same as it would be from any other income. So if corporation tax is 28%, your tax rate on your dividends is 28%, already paid at the company level. Or if you're in the higher bands, 40 or 50%, just as with any other income (and yes it does get very much more complex but this is good enough) and made up of your paying further income tax on your received dividends.

There are tax systems where there is no tax on dividends at all: a higher corporate tax rate being used instead.

So in the UK system from $100 of profits that are to be paid as dividends the tax rate is 28% (the current corporate income tax rate), or $28, if you are a lower rate taxpayer or $40 ($28 at the company level, another $12 individually, at the very top, another $22) if you are a higher rate taxpayer. Tax rates of 28% or 40% or 50%, very similar to other income sources.

In the US system from our $100 first we take $35 at the corporate level. Then we take another $15, or the dividend tax rate of 15%, from the recipient. Giving us a tax rate of 50% on dividends. We've taken $50 from the total amount that was to be used to pay dividends.